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Investing 101: Understanding Terms & Concepts

So you’re new to investing and aren’t sure where to start. All of the financial lingo makes your head spin. I hear you! I felt so overwhelmed when I started treading into the investing waters, but realized after spending some time researching that you can get pretty far by understanding a few basic concepts. As I discussed in my previous series on financial basics, you should really only consider investing if you’ve paid off debt and started an emergency fund. Then, based on your financial goals, you can start putting your money where it will grow.

In future posts, I will be discussing investing research and strategies in more detail. First, it’s helpful to understand some key terms and concepts:

Stocks: Owning a stock means you own a proportional chunk of a specific company. You can buy stocks through a brokerage or sometimes directly from the company. The value of a stock is determined by the stock market, which may or may not be reflective of the actual valuation, profits, etc., of the company. I will discuss the nuts and bolts of understanding stock prices in greater detail in a later post.

Bonds: Bonds are considered “fixed income” meaning the amount of interest they will pay you is determined at the time you buy them. They generally have a set “maturity” date, as well, that is the date you would get your investment back with the promised interest. Bonds can be issued by governments or corporations.

Mutual Funds and ETFs: A mutual fund is an investment vehicle where investors’ money is pooled to buy a collection of assets like stocks, bonds, cash, etc, as determined by the specific funds’ strategy. They are run by professional money managers who invest the pool of money on behalf of investors and attempt to return a profit. ETFs are just like mutual funds but trade like stocks, meaning you can buy and sell them at any point during the trading day.

Broker or Brokerage Account: This is a company that places orders on your behalf for the various financial investments listed above, usually for a fee. They often offer many types of accounts and other services, too, depending on the specific broker.

401(k)s, 403(b)s, and IRAs: These are types of investment accounts specifically designed for retirement planning. The biggest differences among them are that 401(k)s and 403(b)s are set up through an employer while you can open an IRA directly through a broker. 401(k)s are used by for-profit corporations, while 403(b)s are only available for tax-exempt organizations. The investment options in 401(k)s and 403(b)s are often limited by the plan administrator, where you have unlimited investment options in an IRA. All of these plans have annual contribution caps (the amount of money you can put into them) set by the government.

Compounding: When you initially invest an amount of money, then subsequently reinvest any earnings on that money, those earnings start to earn interest, too, causing your money to grow more quickly. Here’s an example: say you invest $100 and it returns 5% a year. At the end of year 1, you will have $105. If you continue reinvesting your profits, those profits will also earn a return every year. By year 10, you will have $163 at a 5% annual rate because your profits were also earning profits. (Note that if your profits were not reinvested, you would only have $150 after 10 years.)

Stock Market Index or Indexing: Indexing is a method of measuring the value of specific group of stocks. These indicies can track anything from a specific market sector to a geographic region. Some examples of indicies you have likely heard reported on the news are the S&P 500 and NASDAQ. While you can’t directly invest in an index (because it’s just a mathematical computation), there are many mutual funds and ETFs that track these indicies in which you can invest.

Ticker Symbol: This is a collection of letters (and sometimes numbers) indicating a specific stock, mutual fund, ETF, etc., on an exchange. Stock symbols have 1-5 letters, depending on the rules of a specific exchange. Mutual funds generally end with the letter “X” to differentiate them from stocks.

There are tons of other terms you may come across, but these are some of the biggies that will help as we dive in further. A great resource for looking up definitions of financial terms is Investopedia, if you find some you’re unsure of.

Have questions about financial concepts? Ask them in the comments below!